How to calculate retained earnings (formula + examples)

Retained earnings. While the term may conjure up images of a bunch of suits gathering around a big table to talk about stock prices, it actually does apply to small business owners. Even the ones who’ve ditched the dress shoes for crocs and a boardroom for a remote office. 🙌

But how, why, and when? We’ll go through all of this and more as we break down the importance of considering retained earnings during your accounting cycle. Here are some of the things we’ll cover:

• How do I calculate retained earnings?

• How do I find retained earnings?

• What is the retained earnings formula? How do I find beginning retained earnings?

• What’s the difference between retained earnings and revenue?

• How much should my retained earnings be?

What are retained earnings?

Let’s cut straight to the chase: What are retained earnings? 

In non-accounting language for the everyday small business owner, retained earnings are the portion of profits set aside to be reinvested in your business.

In more practical terms, retained earnings are the profits your business has earned to date, minus any dividends or other distributions paid to investors. Don’t have investors? You’ll still want to know your retained earnings. It’s a valuable tool in your accounting toolbox to get a better understanding of your business and how you can grow. But more on that later. 👇

How to find retained earnings

Wondering where to find retained earnings? Easy. Retained earnings are shown in two places in your business’s financial statements:

• On the bottom line of your income statement

• In the shareholder’s equity section of your balance sheet‍

How to calculate retained earnings

Now that you know what retained earnings are and why they’re important for your business, let’s get into the math. And don’t worry—this won’t be anxiety inducing. To calculate your retained earnings, you’ll need three key pieces of information handy.‍

1. Find your beginning retained earnings balance

Retained earnings are calculated to-date. This means they accrue from one period to the next.

To begin calculating your current retained earnings, you’ll need to know what they were at the beginning of the time period you’re calculating (this is typically the previous quarter or year). You can find the beginning retained earnings on your balance sheet for the prior period.

2. Find your net income (or loss) for the current period

Wondering what net income or net loss is? In accounting speak, it’s a fancy term for “profit”... or lack thereof. But we don’t love accounting speak. (No offense, accountants.)

Essentially, it’s the total income left over after you’ve deducted your business expenses from total revenue or sales. You can find it on your income statement, also known as profit and loss statement.

3. Find dividends paid to shareholders during the quarter or year

If your business currently pays shareholder dividends, you’ll need to subtract the total paid from your previous retained earnings balance. If you don’t pay dividends, you can ignore this part and substitute $0 for this portion of the retained earnings formula.

What is the retained earnings formula?

Once you have all the numbers you need, outlined in the steps above, it’s time to get out the calculator. And remember: this part’s easy! Here’s the basic formula to calculate retained earnings:

Beginning retained earnings + Profits or losses for the period – Dividends paid = Retained earnings
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See what we mean? Once you have all the data you need, figuring out your retained earnings is actually a pretty simple calculation—no trigonometry class flashbacks or math sweats required.

Example of retained earnings calculation

Let’s take a look at an example of our formula in the real world. Savina is a creative director and founder of her own boutique design agency. She just visited Mexico City to meet with a few potential clients, and is now dreaming of opening up a second office with an in-house team dedicated to her (hopefully) new clients.

But to make her small business dreams a reality, Savina needs to bring in an investor to help with the expansion. The investor wants to know what retained earnings look like to date.

Financials for Savina’s most recent quarter look like this:

• Beginning retained earnings: $100,000

• Net income: $15,000

• Dividends paid: $10,000

So here’s Savina’s retained earnings formula: [$100,000] + [$15,000] - [$10,000] = $105,000
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That means Savina has $105,000 in retained earnings to date—money she can use toward opening additional locations in her new favorite city. 

Another example of retained earnings calculation

Here’s another example. Herbert is the owner of Barking Bots, a startup that sells—you guessed it—robot dogs.

The business is seeing great returns, and Herbert wants to hire new developers. But before he can hire any new employees, he needs to know how much money he has on hand to invest in his business’s growth.
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This is Barker Bots’s information for the year:

• Beginning retained earnings on January 1: $93,000

• Net income for the year ended December 31: $14,000

• Dividends paid: $22,000

With this data, we can find Barker Bots’s retained earnings formula: [$93,000] + [$14,000] - [$22,000] = $95,000

Given the market and salaries required for developers, Herbert comes to the conclusion that with $95,000 in retained earnings to date, Barker Bots isn’t in the position to hire more than one developer.

Retained earnings FAQs

Why are retained earnings important for small business owners?

Retained earnings are an important part of accounting—and not just for linking your income statements with your balance sheets. Retained earnings are a critical part of your accounting cycle that helps any small business owner grow their business. How? It’s the number that indicates how much capital you can reinvest in growing your business.

For example, if you’re looking to bring on investors, retained earnings are a key part of your shareholder equity and book value. Looking for a small business loan? This number’s a must.

Ultimately, before you start to grow by hiring more people or launching a new product, you need a firm grasp on how much money you can actually commit.

What’s the difference between retained earnings and revenue?

Retained earnings represent the total profit to date minus any dividends paid.

Revenue is the income that goes into your business from selling goods or services. It represents the total capital a business generates in gross sales. It doesn’t take costs, expenses, or dividends into account.

Revenue is also typically measured period-by-period. That’s distinct from retained earnings, which are calculated to-date.

What are beginning retained earnings?

Beginning retained earnings is the last year’s retained earnings. It’s used when calculating the retained earnings in the current year.

At the end of every accounting cycle, you’ll see retained earnings on the balance sheet. This is the cumulative incomes from the current year’s earnings and the previous years, save for any dividends distributed to shareholders.

In your next accounting cycle, your ending balance of retained earnings from the last period will be the beginning balance for retained earnings: i.e. “beginnign retained earnings.”

Are beginning retained earnings always positive? 

No, beginning retained earnings aren’t always in the positive. If you see your beginning retained earnings as negative, that could mean that the current accounting cycle you’re in has a larger net loss than your beginning balance of retained earnings. It could also be the rest of dividend distribution. For example, if the dividends a company distributed were actually greater than retained earnings balance, it could make sense to see a negative balance. 

How much should my retained earnings be?

Typically, retained earnings are judged based on their relationship to a company’s total assets. The ideal ratio between retained earnings and total assets is 1:1 (or 100 percent). That said, this ratio is unrealistic for most businesses, so don’t sweat it if you aren’t there. (Remember, Herbert’s not either!)

Retained earnings numbers vary from business to business, and there’s no one-size-fits-all number you can aim for. However, a realistic goal is to get your ratio as close to 100% as you can, taking into account the averages within your industry. From there, you simply aim to improve retained earnings from period-to-period.

What are the disadvantages of calculating retained earnings?

While understanding your retained earnings is important for business owners, and a requirement in many situations, it does have its drawbacks.

For one, retained earnings calculations can yield a skewed perspective when done quarterly. If your business is seasonal, like lawn care or snow removal, your retained earnings may fluctuate substantially from one quarter to the next. Therefore, the calculation may fail to deliver a complete picture of your finances.

The other key disadvantage occurs when your retained earnings are too high. Excessively high retained earnings can indicate your business isn’t spending efficiently or reinvesting enough in growth, which is why performing frequent bank reconciliations is important. Lack of reinvestment and inefficient spending can be red flags for investors, too.

That said, calculating your retained earnings is a vital part of recognizing issues like that so you can rectify them. Remember to interpret retained earnings in the context of your business realities (i.e. seasonality), and you’ll be in good shape to improve earnings and grow your business.

The bottom line on retained earnings

You don’t have to work for a giant corporation to know and understand your business’s retained earnings. This calculation will give you the data to know what portion of your profits can be set aside to be reinvested in your business.

Retained earnings are also much more than just a number. They’re like a link between your income statement (aka your profile and loss statement) and your balance sheet. Retained earnings are recorded under shareholders’ equity, showing how these earnings can be used as a tool to generate growth. That growth may be new equipment, new staff, or implementing a new idea or business, and your retained earnings can help you determine how much you’re able to reinvest (if any at all).

The key to determining your retained earnings is having the right information at your fingertips. That’s your beginning retained earnings, profits or losses for the period, and your dividends paid. And while that seems like a lot to have available during your accounting cycles, it’s not. At least not when you have Wave to help you button-up your books and generate important reports.